If a pension plan has high average worker age, say 57.5, what’s its time horizon? Schweser says it’s short. But I have doubts. I remember seeing somewhere that as a going concern, the pension plan’s time horizon is long term; another place says that it can be multi-stage, from average worker age to retirement age and post retirement. So what should I do on the exam?
While the overall pension plan may have a long-term view as a going concern, its liabilities are very much short term due to the large amount of the company’s workforce that is set to retire and begin collection pension income.
if the average age is 57.5, then assuming most workers retire around 65 years of age, this pension plan has a short - medium time horizon of about 7.5 years. which is clearly not a long term time horizon. just because the plan will be in perpetual existance does not make the plan long term. The average maturity of the liabilities determines the plan time horizon. The liabilities are the payments to the average worker.
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^agree
I’m not sure I agree with the time horizon being about 7.5 years. I believe that pension plans are a going concern and do have a long time horizon. The key will be to address the liquidity needs in the liquidity constraints section and mention that because of the average age being so high, their ability to take risk is reduced despite having a long time horizon.
PJ - i wouldn’t disagree with me on this one… pension plans have an average time horizon of what i said above. Just because they operate (hopefully) into perputity does not necessarily equate to a long time horizon. The work force characteristics determine time horizon.
PJ, If your liabilities are primarily due in less than 10 years or so, why would you have a long time horizon? Totally agree with you here striker on this one…
I’d go with PJ on this one. Key point is that pension liabilities will START to be paid in 7.5 years, but that’s just the first payment. Pensions are paid monthly over the lifetime of the retirees and that could be another 20 years! Put another way, your requirement to investment the plan assets doesn’t stop just because the last employee retired. If the plan’s still paying monthly pensions, you still gotta keep investing. Your best bet is to acknowledge some reduction in time horizon due to higher than average age of the group, but I wouldn’t go as far as saying it’s short (unless all you have is a bunch of 80 year old retirees). There’s some validity to the multi stage view when you look at a single employee retiring in 7.5 years. But when you look at a group of employees gradually retiring over the 0 to 15 years (averaging 7.5) it’s more of a gradual adjustment in risk and liquidity constraints, not a sudden shift.
i suggest you do some CFAI pension questions, or scweser book 6… actually, i suggest you don’t…we can’t have everyone passing.
Read section 2.1.4, there are a number of factors (not just average age of active lives) that dictate time horizon. Some of them are discussed in this post. Some of them are not. But in no place in that section (or in the questions, which I have done) do they ever describe the time horizon as being short. They use the terms “shorter” or “relatively short” but they never say “short” in absolute terms. If Schweser says it’s short then Schweser is wrong. It wouldn’t be the first time. Trust me on this one, on this topic, I know what I’m talking about (as opposed to many many other topics).
It’s defintely Short Time Horizon. See one of the Old CFAI Exams. Yes Pensions are typically considered to have Long TIme Horizons but that isnt written in stone. If you have a high average age of workforce you will have a shorter time horizon.
I think we are mixing the real world and the cfa world… In the real world, if the company is a going concern and everything is under control, perhaps there is no reason to terminate the plan, new employees substitute retired employees, and the plan keeps going and going and actually time horizon = forever. Ok, in the CFA world, I would just look at current situation and age of current employees. End of it, at least for exam purposes. So I have to agree with bigwilly and strikershank. For example, tooOld4this, you don´t know how the company is going to pay the benefit, imagine that, instead of monthly payments, every employee gets a lump sum at retirement… Anyway, I would not disagree with previous official CFA answers (actually I would tatoo past cfa exams and their official answers all over my body, like in prison break)
haha…that woudl be awesome.
Let me give you a related example. If an individual investor is 55 years of age and is retiring at age 62 and at that time he will start drawing down on his investments to provide retirement income, would you say his time horizon is 7 years? Obviously, the investor’s time horizon is longer… The key is that a Pension Plan is an ongoing concern unless stated otherwise. The fact that it has higher liquidity needs due to an aging workforce does not impact it’s long term time horizon. Perhaps the best thing to do is say that the time horizon is “SHORTER” without coming right out and saying it’s SHORT-TERM. I haven’t yet looked at the practice exams so perhaps my opinion will change once I see them. For those that have done those questions, does the CFAI specifically state that the time horizon is SHORT or do they say that the time horizon is SHORTER than it would otherwise be due to the aging work force? PJStyles
PJ you are mixing Individual IPSs with Corporate Pension Plans¡Kthey are like Oil and Water ƒº well not really but think of it in that sense¡Kwhat holds for oen doesn¡¦t hold for the other. They specifically state its SHORT ¡V TERM. Usually there is more to this case than just higher average age, I think that¡¦s what you are getting caught up on. I think for this example it lowered their retirement age also, and closed it off to new entrants. I could be wrong and confusing it with another¡K
Ahhh… well there you have it “Closed off to new entrants”. That would mean that the time horizon is definitely short and it’s no longer a going concern. But making a blanket general statement that a pension plan’s time horizon is short because the average age of a work force is 55 without any other mitigating factors is pure nonsense, particularly if the pension plan is going to be ongoing and providing for new entrants into the plan, like most do.
tend to agree with PJ and tooold4this… did remember one of the past Qs mentioned relatively shorter… but shouldn’t be short-term. the time horizon should be determined by the last payment, which no one knows (even with a bunch of 80 yo) since you do have longevity risk there, which need to be covered…
Ignore.
Guys… you’re confusing RISK TOLERANCE with TIME HORIZON. The ability of a pension plan to take risk is effected by: 1. Funded Status 2. Profitability & D/E Ratios 3. Correlation of Pension Assets w/Firm’s Operations 4. Demographics of Participants (Avg. Age, Retirees to Active Lives ratios etc) So do all of the above impact the ability of a firm to take risk with it’s pension plan, of course they do but they DO NOT impact the Time Horizon unless other factors are at play ie: No longer an ongoing concern.
PJ yes the do have to do with Time Horizon. If the Firm isn’t profitable it’s a going concern, hence Short Time. If the Funded Status is very Underfunded the Pension plan could be in trouble, hence a Short Time. If the Demographics is High Avg Age with a high ratio of Retirees to Active, then it is Shorter Time also. The only one that isnt’ is Correlation. All the above ex-correlation impact both the TIME and RISK. Time and Risk are both a function of each other. Well Risk is more a function of Time.